What is Financial Literacy and Why is it Important?

BY BRANDON VAGNER, CPA, Ph.D., & WALLET WIT FOUNDER

What-is-Financial-LiteracyFinancial literacy is an extremely important life pillar that surprisingly many people neglect. Financial literacy can help you live one heck of a life, but a lack of financial literacy can have catastrophic life consequences. Within this article I’m going to discuss everything you could possibly be wondering about financial literacy.

Ultimately, the lack of financial literacy worldwide is one of the primary reasons why I started this Wallet Wit blog. Being a Certified Public Accountant (CPA) and a college professor, I get a lot of exposure to people and their insights on financial topics. I’m constantly in complete shock at how little people know about personal finances. It makes complete sense though because many of them simply were never taught finances. They didn’t get the introduction to personal finances as a child and, unless they went looking, never got the much needed introduction to personal finances as an adult either.

Our world needs more advocates for financial literacy teaching people the ins and outs of it. We need a wave of personalities with different schools of thought giving people the financial knowledge needed to succeed in life, but, possibly more important, we need the students of financial literacy to turn into advocates themselves. This means actually talking about finances at the diner table. Yes, I know it’s currently viewed as taboo to talk finances, but that school of thought needs to change.

What is Financial Literacy

Financial literacy is the possession of knowledge and skills that enables people to make judgments and decisions regarding money. Knowledge and skills in areas such as budgeting, investments, and debt are some of the most important components of financial literacy. That said, there is a wide spectrum of financial literacy, and it is important to understand where you currently fall on that spectrum. Some people refer to this as your financial IQ.

I’ll simplify it for you. If you can’t thoroughly explain the following questions, then you definitely could use financial literacy improvement.

(1) What is the maximum percentage of your take home pay that should go towards your mortgage?

(2) What is a 529 plan?

(3) What is the difference between a 401K and a Roth IRA?

These are just a few basic questions to gauge your financial literacy. If you know all three answers, that doesn’t automatically mean you are a financial expert. However, if you struggled with any of these questions, you absolutely could use financial literacy improvement.

Why is Financial Literacy Important?

Being able to make high quality judgments and decisions regarding money can be the difference between a good and bad quality of life. It’s not all about getting wealthy, which certainly is a common byproduct of financial literacy. Rather, it’s about learning how to manage what you do have and not making a bonehead decision that could cripple your finances or undermine your wealth building power.

The importance of financial literacy is recognized by many organizations worldwide such as the Financial Literacy and Education Commission along with many others. Financial literacy truly has the power to change your life. In the world we live in, there are certainly things that have the power to improve your life, but the tricky thing about financial literacy is that it also has the power to make your life miserable if you lack it.

Lack of Financial Literacy & Its Impact

Here is a mind blowing statistic for you. In a recent TD Ameritrade report, their survey results show that 53% of their sample population between the age of 50-59 has less than $100,000 saved for retirement! Really digest that. Imagine yourself in your 50’s with that amount in retirement savings and only being 10 years or so away from the typical retirement age. How in the heck are you supposed to live off of $100,000 for 25+ years? You can’t, and that’s one reason why so many people are in financial trouble.

The lack of financial literacy has even infiltrated local, state, and national governments. Just look at how much debt the United States has and how mismanaged some states are. At the end of the day, governments are ran by people. If we want to improve our country’s financial stability, it starts at all the diner tables across the country. Parents need to be teaching their children about finances so the next generations can turn things around.

If you want an easy example of how financial literacy has the power of worldwide impact, just take a quick look back at the financial crises of 2008. A huge aspect of that crisis was the fact that people were buying houses with mortgages they had no business getting. Meaning, people couldn’t afford their houses. Banks were lending people these huge loans for their homes, and people just went with it because they simply thought “if the bank is willing to loan it to me, I must be able to afford it.” That specific example of lack of financial literacy brought many parts of the world to its knees. If only people knew better.

How to Teach Your Kids Financial Literacy

Financial literacy is best learned at an early age in life, and the learning can begin much sooner than most think. Around the age of 5 is when you should start introducing simple financial concepts.

When your child is about 5 years of age, get them a “primary” piggy bank or just use an empty glass jar if that’s all you have. Next, get them two separate smaller piggy banks or jars. This is very important for teaching them financial management. It’s difficult for anybody to manage something with no organization, and that’s where the separate piggy banks come into play.

In adulthood, I recommend having one primary checking account to pay things like your monthly mortgage, electrical, and water bills. I then recommend having a separate second account for food costs and a third account for all your spending such as fun, clothing, oil changes, etc. By having these 3 separate checking accounts, you can allocate your monthly budget to them and your balance works downward to $0 throughout the month. This type of digital cash envelope system helps keep your personal finances well organized.

Children can learn this type of savings management at an early age via the 3 separate piggy banks. The “primary” piggy bank should represent their savings account. This money isn’t to be touched. It will help them understand that growing a nest egg is important and contributing to the nest egg should be a top priority.

The second smaller piggy bank should represent their fun money. This is money they can decide how to spend. Let them learn at an early stage in life that blowing all their fun money quickly results in no more money for fun until they earn more money. There is no “borrowing” from the primary piggy bank or mom and dad. It’s important they learn to make their fun money last and when it’s gone, it’s gone. The third smaller piggy bank should represent their giving money. Regardless of whether you’re religious or not, giving is just the right thing to do. Other personal finance personalties have this same view on giving.

The last step is to determine a percentage split to teach your kids. I always lean toward conservatism. I’d rather teach them to save a higher percentage as a kid to really ingrain in them the importance of saving. I recommend 50% of their money goes directly into the “primary” piggy bank. I then recommend 40% goes into their fun piggy bank. Any lower of a fun money percentage makes it really hard for them to build up their fun piggy bank. That leaves the remaining 10% to be allocated to their giving piggy bank. Adjust these percentages as you see fit, but these would be my recommendations.

How to Become Financially Literate

To become financially literate takes a desire to better your financial situation and persistence. There are many resources out there to help you such as the Wallet Wit website you are on right now. Just by reading this article, it means you have a desire to improve your financial literacy. To multiply that desire 10x, keep reading. Don’t stop with just this article. Make it a goal to read through one personal finance article a day. As you read personal finance articles day in and day out, your desire to become more financially literate will grow exponentially.

Surround Yourself with Financially Savvy People

Both in-person and online, surround yourself with financially savvy people to become financially literate. The age-old saying that you are the average of the 5 people you hang around with most applies directly to financial literacy. It’s incredibly important to have people in your life that know how to manage money. You can learn from their example, and hopefully they openly share with you their insights into money management. Be aware though that most people don’t like talking about money or giving money advice. So, don’t be surprised if all you get from your in-person relationships are examples gained from observing their personal finance habits. Try and ask as many questions as you can though.

If you really want to learn more about personal finances to help improve your financial literacy, start following personal finance personalities online. For example, I’m a Certified Public Accountant (CPA), college professor, business owner, personal finance nut, and business advisor. I openly share financial tips and strategies all the time. It’s what I do. I don’t just share my hypothetical thoughts either. I share exactly what I personally do and the lessons I’ve learned along the way. You need to have a few blogs like mine in your back pocket to read on a consistent basis.

Ignore the Financially Ignorant

Listen, there are so many people out there who have no clue how to manage money or their personal finances. You don’t want to be taking advice from people who are financial disasters. You know exactly who these people are in your life! You have to do your best to ignore their money behaviors.

Once you start taking control of your personal finances and really begin making changes in your life, be prepared for heavy criticism from financially ignorant people. For some reason, they love to call financially savvy people crazy for the types of financial decisions they make. It’s because they don’t understand the bigger picture of finances, your personal finance goals, or the necessary steps to become financially secure. Just ignore all the criticism and practice good financial behavior and strategies.

Be Persistent with Your Personal Finances

Personal finance is a marathon. You have to be diligent in your strategies and consistent with your behaviors over a long period of time. Persistence, by definition, is a firm continuance course of action in spite of difficulty or opposition. I’ve already mentioned examples of opposition you will face, and it certainly will be difficult at times when your mind tells you to just put something on a credit card and worry about it later. You can’t fall victim to that. You must remain firm in your actions toward a goal of becoming financially secure. Be persistent my friends!

Are Wealthy People Financially Literate?

Just because someone is wealthy, does not mean they are financially literate. Our world history has many examples of very wealth people losing it all. Some of the most reported on examples come from lottery winners, but there are many other examples of people who lost family fortunes.

Be very careful to associate high levels of income with financial literacy. Most of us know a doctor in town that lives in a mansion, drives an expensive sports car, has a second house, and wears expensive clothes. Don’t let that fool you. Many of them have insane amounts of student loan debt, a huge mortgage on that mansion, personal loans through the local bank, and credit card debt up to their ears. Yes, they might make $250,000 per year, but they might also be spending every last dime and then some.

That said, there are certainly wealthy people who are financially literate, but you likely wouldn’t even know they are wealthy. These are people who fly under the radar and live modestly. These are the people you want to find in your local community and learn from.

Can Financial Literacy Help Your Career?

Yes, financial literacy can absolutely help your career. Many people think financial literacy only applies to their money in the bank. However, it goes well beyond that and has the power to impact your career trajectory.

First off, some companies might run your credit report before hiring you. Their thought process is that diligent and responsible people should have their personal finances in good order. That said, your financial literacy can directly impact your ability to get hired.

Once hired and on your climb up the ladder, upper management will want to observe your ability to manage teams and/or departments. That typically comes with a financial component. Thus, your ability to understand budgeting is vital to your upward mobility. I know a gentleman who was up for a huge corporate sales promotion. They gave him and the other candidates a financial oriented test to gauge their level of financial literacy as it relates to budgeting and financial statements. Admittedly, the gentlemen told me he bombed the test because he never paid attention in any of his financial classes. That shortcoming of his is what ultimately cost him the big promotion.

Can Financial Literacy Help Your Marriage?

Absolute! Money is one of the top three leading reasons for divorce. If you want a successful marriage, it’s extremely important both you and your spouse are financially literate. I can’t stress this enough.

I wrote an article on how to audit your monthly spending, and it outlines some money management mistakes my wife and I made early in our marriage. The key was that we both recognized there had to be a better way to manage our money. Things had worked well for us up to that point because neither of us did dumb things when it came to money, but we took our eye off the ball for a short period of time and things got slightly off track. Luckily, we both were pretty financially literate, and that allowed us to work nicely together to solve our money issues at the time.

That said, many couples really struggle when it comes to personal finance because both people aren’t on the same page. Having a spouse in life is like having a teammate. If you’re going into an athletic competition, you want the most capable and skilled teammate possible. That said, you want someone who is well equipped but also willing to put the time in to learn and grow in an effort to become better and help your team. The same goes for marriage. Instead of being physically and dietary literate for purposes of high level athletic competition, you and your spouse both need a life partner who is financially literate, because financial literacy is a relationship pillar.